The financial system moves scarce funds from savers to borrowers to finance investment and economic growth. It performs key functions like channeling savings into investment, providing liquidity and means of payment, managing risk, and supplying credit. Financial markets allocate resources, distribute income, and determine interest rates, directing the flow of funds. Together the global financial system and markets enable production, consumption and economic development.

1. The Financial SystemThe Financial System
A collection of markets,A collection of markets, institutionsinstitutions,,
laws, regulations, and techniqueslaws, regulations, and techniques
Bonds, stocks, and other securities areBonds, stocks, and other securities are
tradedtraded
Interest rates are determinedInterest rates are determined
Financial services are producedFinancial services are produced
Financial services are delivered aroundFinancial services are delivered around
the worldthe world
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2. The Primary Task of the Financial SystemThe Primary Task of the Financial System
It moves scarce loanable funds.It moves scarce loanable funds.
Funds are shifted from those who save.Funds are shifted from those who save.
The funds are moved to those whoThe funds are moved to those who
borrow to buy goods and services andborrow to buy goods and services and
to make investments in new equipmentto make investments in new equipment
and facilities.and facilities.
That movement enables the globalThat movement enables the global
economy to grow and the standard ofeconomy to grow and the standard of
living to increase.living to increase.
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3. Flows within the GlobalFlows within the Global
Economics SystemEconomics System
Basic function of theBasic function of the economic systemeconomic system
 Allocate scarce resources; land, labor,Allocate scarce resources; land, labor,
management skill, and capitalmanagement skill, and capital
 Produce the goods and services needed byProduce the goods and services needed by
societysociety
The global economy generates a flow ofThe global economy generates a flow of
production in return for a flow ofproduction in return for a flow of
paymentspayments
The circular flow of production andThe circular flow of production and
income is interdependentincome is interdependent
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4. Circular Flow of Income, Payments, andCircular Flow of Income, Payments, and
Production in the Global Economic SystemProduction in the Global Economic System
Producing units
(mainly businesses and
governments)
Consuming units
(mainly households)
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5. The Role of MarketsThe Role of Markets
in the Global Economic Systemin the Global Economic System
Most economies around the world relyMost economies around the world rely
principally uponprincipally upon marketsmarkets to carry outto carry out
the complex task of allocating scarcethe complex task of allocating scarce
resources.resources.
The marketplace isThe marketplace is dynamicdynamic. It. It
determines what goods and servicesdetermines what goods and services
will be produced and in what quantitieswill be produced and in what quantities
through theirthrough their pricesprices..
Markets also distributeMarkets also distribute incomeincome byby
rewarding superior producers withrewarding superior producers with
increased profits, higher wages, andincreased profits, higher wages, and
other economic benefits.other economic benefits.
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6. Three Types of MarketsThree Types of Markets
 TheThe factor marketsfactor markets
 Allocate factors of production (land, labor,Allocate factors of production (land, labor,
skills, capital)skills, capital)
 Distribute income (wages, rent) to theDistribute income (wages, rent) to the
owners of productive resourcesowners of productive resources
 TheThe product marketsproduct markets
 Allocate goods and servicesAllocate goods and services
 Consuming units use most of their incomeConsuming units use most of their income
in this marketin this market
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7. Three Types of MarketsThree Types of Markets
TheThe financial marketsfinancial markets
 Allocate savings to individuals andAllocate savings to individuals and
institutionsinstitutions
 Those that need more funds for spendingThose that need more funds for spending
than are provided by their current incomesthan are provided by their current incomes
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8. Types of MarketsTypes of Markets
Producing units
(mainly businesses
and governments)
Consuming units
(mainly households)
Flow of funds
(savings)
Flow of financial
services, income, and
financial claims
Financial markets
Flow
of production
Product markets
Goods and services
Flow
of payments
Flow
of payments for
consumption and taxes
Flow
of incomesFlow
of incomes Factor markets
Productive servicesProductive services
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9. Financial Markets and the Financial System:Financial Markets and the Financial System:
Channel for Savings and InvestmentChannel for Savings and Investment
Nature of savingsNature of savings
 Households: current income – taxHouseholds: current income – tax
payments – consumption expenditurespayments – consumption expenditures
 Businesses: retained earningsBusinesses: retained earnings
 Governments: current revenues –Governments: current revenues –
expendituresexpenditures
Nature of investmentNature of investment
 Households: purchase of a homeHouseholds: purchase of a home
 Businesses: expenditures on capital goodsBusinesses: expenditures on capital goods
and inventoriesand inventories
 Governments: building/maintaining publicGovernments: building/maintaining public
facilitiesfacilities
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10. Financial Markets and the Financial System:Financial Markets and the Financial System:
Channel for Savings and InvestmentChannel for Savings and Investment
The financial markets enable theThe financial markets enable the
exchange of current income for futureexchange of current income for future
incomeincome and theand the transformation oftransformation of
savings into investmentsavings into investment so thatso that
production, employment, and incomeproduction, employment, and income
can grow, and living standards improve.can grow, and living standards improve.
The suppliers of funds to the financialThe suppliers of funds to the financial
system expect not only to recover theirsystem expect not only to recover their
original funds but also to earnoriginal funds but also to earn
additional income as a reward foradditional income as a reward for
waiting and assuming risk.waiting and assuming risk.
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11. The Global Financial SystemThe Global Financial System
Flow of financial
services, incomes, and
financial claims
Demanders
of funds
(mainly
businesses
and
governments)
Flow of loanable funds
(savings) Suppliers of
funds
(mainly
households)
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12. Function Performed by the Global FinancialFunction Performed by the Global Financial
System and the Financial Markets: SavingsSystem and the Financial Markets: Savings
Provides a channel for the public’sProvides a channel for the public’s
savingssavings
 Profitable outlet for utilization of savingsProfitable outlet for utilization of savings
 Relatively low-riskRelatively low-risk
Savings flow through the financialSavings flow through the financial
markets to investments allowing themarkets to investments allowing the
economy to increase productioneconomy to increase production
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13. Function Performed by the Global FinancialFunction Performed by the Global Financial
System and the Financial Markets: WealthSystem and the Financial Markets: Wealth
Wealth is the value of accumulatedWealth is the value of accumulated
savings built up over timesavings built up over time
 Financial instruments provide an excellentFinancial instruments provide an excellent
way to store wealthway to store wealth
 Financial instruments do not depreciate andFinancial instruments do not depreciate and
often generate incomeoften generate income
 Financial instruments have less risk thanFinancial instruments have less risk than
many other forms of wealth storingmany other forms of wealth storing
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14. Function Performed by the Global FinancialFunction Performed by the Global Financial
System and the Financial Markets: LiquiditySystem and the Financial Markets: Liquidity
Provide liquidity for savers who holdProvide liquidity for savers who hold
financial instruments but are in need offinancial instruments but are in need of
moneymoney
Money is mainly currency and depositsMoney is mainly currency and deposits
held in depository institutionsheld in depository institutions
 Can be spent without need of conversionCan be spent without need of conversion
 Earns the lowest rate of return of allEarns the lowest rate of return of all
financial assetsfinancial assets
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15. Function Performed by the Global FinancialFunction Performed by the Global Financial
System and the Financial Markets: PaymentSystem and the Financial Markets: Payment
A mechanism for making payments forA mechanism for making payments for
purchases of goods and servicespurchases of goods and services
 Certain financial assets have been popularCertain financial assets have been popular
means of exchange (currency, demandmeans of exchange (currency, demand
deposits, etc.)deposits, etc.)
 Growing in popularity are debit and creditGrowing in popularity are debit and credit
cardscards
 Many other instruments are also growing inMany other instruments are also growing in
popularity (ATM cards etc.)popularity (ATM cards etc.)
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16. Function Performed by the Global FinancialFunction Performed by the Global Financial
System: Risk ProtectionSystem: Risk Protection
The financial markets offer protectionThe financial markets offer protection
against life, health, property, andagainst life, health, property, and
income risksincome risks
 Permits individuals and institutionsPermits individuals and institutions
Engage inEngage in risk-sharingrisk-sharing
Engage inEngage in risk reductionrisk reduction
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17. Function Performed by the Global FinancialFunction Performed by the Global Financial
System and the Financial Markets: CreditSystem and the Financial Markets: Credit
Furnish credit to finance currentFurnish credit to finance current
consumption and investment spendingconsumption and investment spending
Policy Function:Policy Function:
A channel through which governmentsA channel through which governments
may attempt to influence the economymay attempt to influence the economy
The task of economic stabilization hasThe task of economic stabilization has
been given largely to central banksbeen given largely to central banks
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18. Types of Financial MarketsTypes of Financial Markets
Within the Global Financial SystemWithin the Global Financial System
 TheThe money marketmoney market is the market for short-is the market for short-
term (one year or less) loans.term (one year or less) loans.
 TheThe capital marketcapital market finances long-termfinances long-term
investments by businesses, governments,investments by businesses, governments,
and households.and households.
 In particular, governments borrow fromIn particular, governments borrow from
commercial banks in the money market, whilecommercial banks in the money market, while
in the capital market, insurance companies,in the capital market, insurance companies,
mutual funds, security dealers, and pensionmutual funds, security dealers, and pension
funds supply the funds for businesses.funds supply the funds for businesses.
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19. Types of Financial MarketsTypes of Financial Markets
Within the Global FinancialWithin the Global Financial
SystemSystem
 InIn open marketsopen markets, financial instruments are, financial instruments are
sold to the highest bidder, and can be tradedsold to the highest bidder, and can be traded
as often as is desirable before maturity.as often as is desirable before maturity.
 InIn negotiated marketsnegotiated markets, the instruments are, the instruments are
sold to one or a few buyers under privatesold to one or a few buyers under private
contract.contract.
 Financial capital is raised when newFinancial capital is raised when new
securities are sold in thesecurities are sold in the primary marketsprimary markets..
 Security trading in theSecurity trading in the secondary marketssecondary markets
then provides liquidity for the investors.then provides liquidity for the investors.
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20. Exchanges and Over the counter (OTC)Exchanges and Over the counter (OTC)
marketsmarkets
InIn exchangesexchanges buyers and sellers ofbuyers and sellers of
securities meet in one central location tosecurities meet in one central location to
conduct trades. Whereas inconduct trades. Whereas in Over theOver the
counter (OTC)counter (OTC) markets buyers andmarkets buyers and
sellers are at different locations and aresellers are at different locations and are
willing to buy or sell securities OTC towilling to buy or sell securities OTC to
anyone who comes to them and willinganyone who comes to them and willing
to accept their price e.g. NASDAQ.to accept their price e.g. NASDAQ.

21. Types of Financial MarketsTypes of Financial Markets
Within the Global Financial SystemWithin the Global Financial System
 In theIn the spot marketspot market, assets or financial services are, assets or financial services are
traded for immediate delivery (usually within twotraded for immediate delivery (usually within two
business days).business days).
 Contracts calling for the future delivery ofContracts calling for the future delivery of
financial instruments are traded in thefinancial instruments are traded in the futuresfutures oror
forward marketforward market..
 Contracts granting the right to buy or sell certainContracts granting the right to buy or sell certain
securities at specified prices within a certain periodsecurities at specified prices within a certain period
are traded in theare traded in the options marketoptions market..

22. Factors Tying All FinancialFactors Tying All Financial
Markets TogetherMarkets Together
Credit, the common commodity.Credit, the common commodity. TheThe
shifting of borrowers among marketsshifting of borrowers among markets
helps to weld the financial systemhelps to weld the financial system
together and to balance the costs oftogether and to balance the costs of
credit in the different markets.credit in the different markets.
Speculation and arbitrage.Speculation and arbitrage. SpeculatorsSpeculators
who gamble on their market forecastswho gamble on their market forecasts
and arbitrageurs who watch forand arbitrageurs who watch for
profitable arbitrage opportunities helpprofitable arbitrage opportunities help
to level out prices and maintain priceto level out prices and maintain price
consistency among the markets.consistency among the markets.

23. The Dynamic Financial SystemThe Dynamic Financial System
The global financial system rapidlyThe global financial system rapidly
changing into a new systemchanging into a new system
The trend toward global integration ofThe trend toward global integration of
financial systemsfinancial systems
 Powered by innovations as new financialPowered by innovations as new financial
services and instruments continuallyservices and instruments continually
appear to attract customersappear to attract customers
 Benefiting from increasing harmonization ofBenefiting from increasing harmonization of
regulationsregulations

24. The Dynamic Financial SystemThe Dynamic Financial System
The results are major changes to theThe results are major changes to the
marketmarket
 Increasingly intense competitionIncreasingly intense competition
 Many new financial servicesMany new financial services
 Increased riskIncreased risk
 A wave of mergers among financialA wave of mergers among financial
institutionsinstitutions
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